Question

Lockboxes and Collection Time
Bird's Eye Treehouses, Inc., a Kentucky company, has determined that a majority of its customers are located in the Pennsylvania area. Therefore, it is considering using a lockbox system offered by a bank located in Pittsburgh. The bank has estimated that use of the system will reduce collection time by two days. Based on the following information, should the lockbox system be adopted?

Average number of payments per day 750
Average value of payment $570
Variable lockbox fee (per transaction) $0.18
Annual interest rate on money market securities 7%

How would your answer change if there were a fixed charge of $5,000 per year in addition to the variable charge?

Shows all the step and formula. Don't round off until you get the answer.

Answer 1

Before fixed cost:

Compute the saving in interest due to the lock-box system, using the equation as shown below:

Savings = Number of payments in a day*Average payment amount*Rate of interest*Time saved

              = 750*$570*7%*2days

              = $59,850

Hence, the savings in interest is $59,850.

Compute the cost of the lock-box system, using the equation as shown below:

Cost = Number of payments per day*Cost per transaction*Number of days in a year

        = 750*$0.18*365 days

        = $49,275

Hence, the cost of the lock-box system is $49,275.

Compute the net savings due to the lock-box system, using the equation as shown below:

Net savings = Interest savings – Lock-box cost

                    = $59,850 - $49,275

                    = $10,575

Thus, the net savings is $10,575. Hence, the lock-box system should be adopted.

After fixed cost:

Compute the net savings due to the lock-box system, using the equation as shown below:

Net savings = Interest savings – Variable Lock-box cost - Fixed cost

                    = $59,850 - $49,275 - $5,000

                    = $5,575

Thus, the net savings is $5,575. Hence, the lock-box system should be adopted.